by Tim Herbert-Smith
It has now been over 18 months since the Companies Act 1989 received the Royal Assent. As befits a statute which was described in Parliament as “a kind of glorified legislative Lancashire Hot-Pot”, its provisions have been introduced piecemeal and a number remain to be implemented. Much has been written about the Act from the accountancy and corporate viewpoint, but the purpose of this article is to summarise those parts of the Act relevant to those involved in property.
It is proposed to look at the following areas:
(1) New definitions of parent and subsidiary undertakings (incorporated as sections 258 and 259 and Schedule 10A of the amended Companies Act 1985).
(2) New definitions of subsidiary, holding company and wholly-owned subsidiary (sections 736 and 736B).
(3) Abolition of the ultra vires rule (sections 35, 35A and 35B).
(4) Execution of documents by companies (sections 36, 36A, B and C).
(5) New procedures for registration of company charges (sections 395-408, 410-423 and 409-424).
Parent and subsidiary undertakings
Parent and subsidiary undertakings were implemented on April 1 1990. One of the main purposes of the Act was to introduce new definitions for accounting purposes to ensure that consolidated accounts present a truer picture of corporate assets and liabilities. The provisions affect company accounts for financial years beginning on or after January 1 1990. A new concept of “subsidiary undertaking” is introduced which contrasts with the definitions used in the 1985 Act. The real test of control rather than the technical test of ownership is the significant factor; not only limited companies but non-corporate undertakings are caught. It is outside the scope of this article to go into detailed definitions and analysis of the provisions, but the effect of the new Act combined with new accounting standards is to bring many off-balance-sheet companies into the parent companies’ consolidated accounts.
This is particularly relevant to property developers. Former methods of off-balance-sheet financing will no longer be available. A joint venture could be constructed in such a way that each participant holds a 50/50 interest and every decision requires unanimous consent. This could be off both participants’ balance sheets, but it is difficult to see how the venture could be successfully managed.
Inventive finance directors have been looking at variations to the traditional sale-and-leaseback as one solution, but this is unlikely to work if there are options and incentives for the vendor to reacquire the reversion. Borrowers may be affected and should check limitations on borrowings in company articles, loan documents etc which may refer to the capital and reserves of the borrower’s consolidated balance sheet.
Definition of subsidiary
A new definition of subsidiary was implemented on November 1 1990. This is not to be confused with the definition of “subsidiary undertaking” which is for accounting purposes only. Under the new definition, a subsidiary “B” is a company in which the holding company “A”:
(a) holds the majority of the voting rights; or
(b) is a member (ie shareholder) of B and has the right to appoint or remove a majority of the board directors; or
(c) is a member and controls alone, pursuant to an agreement with other members, a majority of the voting rights in B.
B is also a subsidiary of A if B is a subsidiary of another subsidiary of A.
It is a wider definition than the 1985 Act definition and this can have some unexpected consequences. The new definition in the Companies Act has been incorporated in section 42 of the Landlord and Tenant Act 1954. Section 42(2) provides that where a tenancy is held by A, occupation and carrying on business by another group member B shall be treated, for the purposes of the security of tenure provisions of Part II of the Act, as equivalent to occupation or the carrying on of business by A. If, for example, A holds a lease but B occupies the premises, A will be entitled to a renewal lease if it controls B’s board, whether or not A is the majority shareholder of B.
A landlord can oppose a new tenancy under section 30(1)(g) if it intends to occupy the premises. Section 42(3) provides that intended occupation by the landlord for the purposes of carrying on its business shall be construed as including intended occupation by any group member for the purposes of a business to be carried on by that member. If A, the landlord of business premises, has a controlling interest in company B, which, operating the same business, intends to occupy the premises, A will be entitled to refuse the tenant a renewal lease.
Many leases contain “group occupation clauses”. These enable holding companies or subsidiaries of the tenant to occupy premises without requiring the landlord’s consent. Such clauses generally refer to the definition within the Companies Acts or the definition in section 42 of the Landlord and Tenant Act 1954. In either case the range of companies which can occupy is widened. Landlords who wish to avoid extending the effect of the clause must ensure that appropriate amendments are made to new leases, either by specifically providing that the lease refers to the 1985 Act as originally enacted or by setting out the preferred definitions in full.
Existing leases may be covered by a specific provision in the Act that the old 1985 Act definition will continue to apply for the purpose of a document, unless the document itself provides that the statute is to be interpreted as amended or re-enacted from time to time. This rebuts the general presumption in the Interpretation Act 1978 that statutory references are to those as re-enacted. In each case, look at the wording of the document itself before deciding which definition applies.
Under the Landlord and Tenant Act 1987, a residential tenant does not have a right to buy the landlord’s reversionary interest if the landlord is disposing of its interest to an associated company. The 1987 Act now incorporates the new definition. This opens up the possibility of disposals to a wider range of companies controlled by the landlord.
Borrowers and lenders are also affected by the new provisions. Articles of association, loan documents etc may limit the borrowings of the company and its subsidiaries. This is an additional complication to the new accounting requirements referred to above. Borrowers and lenders should therefore carefully review both existing and new documentation and consider what changes may be relevant to ensure that borrowers do not find themselves unwittingly in breach of borrowing limits.
Abolition of ultra vires rule
The abolition of the ultra vires rule was implemented on February 4 1991. Much difficulty is caused by the ultra vires doctrine to practitioners and academics alike. Essentially the rule is that a company may carry out only acts which are expressly or impliedly permitted by its objects as set out in its memorandum of association. Important provisions were introduced by the European Communities Act 1972 and subsequent legislation, but these have not been entirely satisfactory in balancing the protection of shareholders against that of third parties when a company acts outside its capacity.
The 1989 Act amends section 35 of the 1985 Act. In relation to corporate capacity it provides that “the validity of an act done by a company shall not be called into question by reason of anything in the company’s memorandum” (section 35(1)). The new section 35A deals with the power of directors and provides that “in favour of a person dealing with a company in good faith, the power of the board of directors to bind the company or authorise others to do so shall be deemed to be free of any limitation under the company’s constitution”.
This provision is much broader than the old section 35 of the Companies Act 1985. On the face of it, it removes the necessity for a third party to know that the transaction was decided upon by the directors. It is also provided that a person should not be regarded as acting in bad faith merely because he knows an act is outside the director’s power under the company’s constitution, ie even if he had actual knowledge of the contents of the memorandum and articles he will not be deprived of protection. Thus, for example, where one branch of a bank has knowledge of a borrower’s memorandum and articles but another branch which makes a loan to the borrower does not, the bank’s position will nevertheless be protected, notwithstanding the borrower’s lack of capacity.
Lenders should nevertheless take care, as:
(1) They will not be protected if the director’s act is illegal, for example, the directors authorise the company to give financial assistance in connection with the purchase by it of its own shares.
(2) They may not be protected where directors act in breach of their fiduciary duties and the lender knows of the breach.
(3) It has been argued that the provisions protect a third party only from decisions of the board of directors and not individual directors.
(4) If the lender is dealing with someone other than the board, whether an individual director or a person purportedly authorised by the board, it will need to be satisfied that the person actually has that authority.
(5) Shareholders have the power to bring proceedings to restrain the company or the directors from acting outside the company’s capacity or the director’s powers, although they will not be able to overturn an agreement already entered into with a third party.
Execution of documents
This was introduced simultaneously with the Law of Property (Miscellaneous Provisions) Act 1989, which dealt with the execution of deeds by individuals. It was implemented on July 31 1990. Like that Act, section 36 has major and unexpected consequences. It is relevant to all companies and provides that the company need not have a common seal. If a document is signed by a director and the company secretary, or by two directors, and expressed to be executed by the company, it has the same effect as if it had been executed under the common seal.
There is, surprisingly, a complication. Section 36A(5) states that a document executed by a company which makes it clear on its face that it is intended to be a deed has effect upon delivery as a deed. It is presumed, unless a contrary intention is proved, to be delivered upon being executed. The problem is that, once the document has been signed and delivered, it cannot be revoked or recalled, even though it may not have been dated. Only if the document has been executed subject to a condition being satisfied, and that condition is not satisfied, will the company not be bound.
In order to avoid this problem arising (unless the intention is that the deed should have immediate effect) companies should amend the attestation clause to read “executed as a deed but not delivered”; and incorporate appropriate words authorising the company’s solicitors to deliver the deed, or providing that the deed be delivered when the document is dated.
Registration of charges
These provisions should be implemented in December 1991. They affect all borrowers and lenders. The Act makes significant changes to the requirements for the registration of charges and the effects of failure to register. It also provides for new procedures for the rectification of inaccurate particulars and late delivery of registration particulars. It is not possible within this article to set out the detailed technical provisions in full; the detailed mechanics of the new procedure are to be prescribed by regulation. Indeed, the Department of Trade and Industry says that Companies House and the Land Registry have yet to put forward proposals for draft regulations. These should be issued for consultation in the autumn.
Two points for lenders and borrowers to note:
(a) Particulars of a charge will not be removed from the register unless a memorandum of release is signed by both the company and the chargee.
(b) Section 410 in the amended 1985 Act empowers the Secretary of State to make regulations which require the registration of an event of crystallisation under a floating charge, whether it occurs automatically or on notice. At present no such regulations have been made.
The flow chart on p 88 may be used for determining the validity of charges.
Conclusion
Major corporate legislation inevitably affects property companies and their lenders. This article offers an overview of the provisions which relate specifically to property matters, but there are many other provisions which to a greater or lesser extent may also be relevant.
New definitions for accounting purposes mean that single-project development companies or partnerships are likely to be consolidated into group accounts.
The new definition of “subsidiary” affects both existing leases and renewal leases in so far as either landlords or tenants may be able to take advantage of the extended definition of group companies. Lenders and borrowers will need to be aware of its effect on borrowing limits and powers.
Abolishing the ultra vires rule and associated amendments gives greater protection to third parties in dealings with companies, but lenders need to take precautions.
The change of formalities for execution of documents can have unexpected consequences unless the terms of execution are clearly stated.
New rules for registration of charges which are to be introduced shortly reduce the responsibilities of the Registrar of Companies, but require full and accurate particulars to be supplied to Companies House within a strict time-limit.
